Tax revenues and dynamics

Tax revenues (net to the Centre) stood at Rs 79,589 crore for the period April to October of the current fiscal year, amounting to 43.2 per cent of the Budget estimate for 2003-04. This is 13 per cent more than the net tax revenue during the same period last year. The target growth rate was slightly higher at 16.3 per cent.

However, the Centre's direct tax collections are expected to meet the Budget target, mainly because of the excellent performance of corporate taxes "" a result of hefty corporate earnings. During the period April to November 2003-04, total corporate tax collection was Rs 21,952 crore, 31 per cent higher than the same period last year.

Corporate taxes overshadowed income taxes, which registered a 7.2 per cent growth in the same period. The combined corporate and income tax performance resulted in a 17.6 per cent growth in total direct tax collection, higher than the Budget estimate of 16.6 per cent.

On the other hand, poor excise collection during April to November 2003 led to just an 8.6 per cent growth in indirect taxes, against the Budget target of 15.5 per cent set for the fiscal. The cumulative excise collection fell short of the target for the eight-month period by about 6 per cent. Customs collections were more or less in tune with the target.

The buoyancy in corporate taxes can be linked to corporate earnings. The slow growth in excise collections can be partially explained by the reduction in duty rates on some items. But the main reason for the higher growth in corporate taxes over excise has to do with the corporate sector's performance.

In the first half of 2003-04, the profitability of manufacturing firms increased at a much faster rate than company sales as a result of two factors: productivity gains and falling interest payments.

Compared to a growth rate of 12 per cent for a set of 1,245 manufacturing companies in net sales in H1 2003-04, the profits before depreciation, interest and tax (PBDIT) grew at 13 per cent, implying some rise in productivity.

The growth in profits before depreciation and taxes (PBDT) at 24.5 per cent was more or less double of that in PBDIT in the corresponding period. Since sales are closely related to excise collections and PBDT to corporate taxes, a relatively higher growth in PBDT vis-à-vis net sales translates into correspondingly higher corporate tax collections.

Thus, as the box shows, for the manufacturing sector as a whole, the contribution to corporate tax growth of productivity-related savings (71 per cent) has been higher than that of interest cost savings (29 per cent).

Which subsectors of manufacturing are contributing to rising profits, which, in turn, is leading to increased tax payments? And, what is contributing more to this gain in profits "" productivity improvement or lower interest payments?

In the manufacturing sector (see table), companies producing petro products, chemicals, metals and those producing diversified products have a relatively larger weight (at least a double-digit share). Weights are in terms of share in net sales during the first two quarters of 2003-04.

Also, these are the sectors contributing the most to direct tax payments. However, these are not the sectors with a higher tax-to-sales ratio. Food, auto components and automobiles have relatively higher tax-sales ratios.

Have these relatively important sectors witnessed higher growth in profits? Petro products with a share of 33 per cent in manufacturing net sales, have witnessed a decline in PBDIT during H1 2003-04 compared to that in H1 2002-03. The net sales of a set of 12 companies engaged in producing petro products increased by 9.5 per cent.

But the PBDIT declined by 7.8 per cent. And, despite declining interest payments, PBDT declined compared to H1 2002-03 as productivity factor dominated the interest saving factor. Even tax payments of petro products went down by 25 per cent during H1 2003-04 compared to the same period last year.

In fact, petro products is the only segment of the manufacturing sector that saw falling tax provisions. The only other sector witnessing negative growth in PBDT is consumer electronics (-58 per cent) but this is also showing positive growth in overall direct tax payments (20 per cent).

Metals are the fastest growing segment. The PBDIT of a set of 100 companies engaged in metal production improved by 71 per cent. Interest costs also declined by around 27 per cent. This increasing PBDIT and declining interest payments led to a whopping 220 per cent increase in PBDT during H1 2003-04 over the first half of the last fiscal. However, rising PBDIT is contributing more to the PBDT (82 per cent) than interest savings (18 per cent).

Most of the manufacturing sub-sectors showed positive growth in sales, PBDIT, PBDT and tax payments and a fall in interest payments. The other segment, which is not following this pattern, is computers (both software and hardware). A set of 135 companies saw rising interest costs, albeit marginally. That is why interest savings are contributing nothing to rising PBDT.

Textiles is another segment that deviates slightly from the pattern. The group of companies producing textiles saw falling PBDIT but rising PBDT, though, marginally. Falling interest payments played a dominant role here.

To sum up, during the first eight months of the current fiscal, direct taxes exceeded the Budget target on the back of buoyant corporate tax collections. Indirect tax collections, on the other hand, fell short of target as a result of lagging excise collections. The relative movements of sales, productivity and interest payments are important in explaining this difference.

There is no doubt that industry, more specifically the corporate sector, is witnessing a recovery and net sales of companies are growing at a decent rate. But PBDT or profitability of firms has increased at a much faster rate than company sales as an outcome of reducing interest costs and productivity gains.

Given that sales are closely related to excise collections and PBDT to corporate taxes, a relatively higher growth in PBDT vis-à-vis net sales translates into correspondingly higher corporate tax collections compared to excise collections.

Reductions in interest costs and rise in productivity is leading to higher growth in profitability compared to sales. For the manufacturing sector as a whole, productivity-related savings contributed about 70 per cent of the increase, while interest cost savings contributed about 30 per cent. There were, of course, significant variations across different industrial segments in this decomposition.

(The author is an economist at Crisil. This is excerpted from a larger article that appeared in the December issue of Crisil Ecoview)